Archive for the ‘AMT’ Category

One of the first things people figure out about tax returns is that deductions on Schedule C are better than deductions on Schedule A. A legitimate Schedule C deduction is fully-deductible whether you itemize or not, for regular taxes or alternative minimum tax. If the deduction is instead an “unreimbursed employee business expense,” it is only deductible if you itemize, only to the extent your “miscellaneous” deductions exceed 2% of your adjusted gross income, and it isn’t deductible at all in computing your AMT.
A Montana investment advisor, a Mr. Purdy, figured out the difference. He worked for Merrill Lynch, where he received a W-2 and filed his returns as an employee for three years. Relationships soured and he sued Merrill Lynch, eventually getting a $393,000 settlement, $120,000 of which went to his attorney.
The taxpayer deducted the attorney fees as a Schedule C deduction for a new investment advisory business he set up. The IRS had other views. The Tax Court this week came down on the side of the IRS:

In addition, the parties treated Mr. Purdy as an employee. The two agreements Mr. Purdy signed consistently mentioned his employment with Merrill. Merrill paid Mr. Purdy a salary, withheld Federal and State taxes, and issued Mr. Purdy a W-2 every year. Mr. Purdy received benefits of the kinds an employee would receive, including health insurance and a retirement plan. Mr. Purdy reported the wages he earned as an employee consistently each year he was working at Merrill and even reported the settlement award as wages despite having been fired. At no time did he report any self-employment income from Merrill. Moreover, he claimed unreimbursed employee business expenses while he was working at Merrill. Mr. Purdy’s tax returns during his tenure at Merrill never included a Schedule C related to his financial adviser activities and instead included his expenses related to his advising as unreimbursed employee business expenses…
Accordingly, we find that Mr. Purdy incurred these legal fees as an employee, not as an independent contractor, sole proprietor, or partner

This highlights a big problem that lawsuit winners often face. They are taxable on the whole lawsuit proceeds, but if the lawsuit arises from employment, the legal fees are a Schedule A deduction — and if you have alternative minimum tax, that’s often the same as non-deductible. After the lawyers and the IRS are done, the lawsuit winner may get the smallest cut of the awards. Moving the deduction to Schedule A cost Mr. Purdy about $42,000.
Cite: Purdy, T.C. Summ. Op. 2010-26.

You can get a miscellaneous itemized deduction by cashing out an underwater Sec. 529 college savings plan, as William Perez explains. Remember, any deduction you get – and miscellaneous deductions only count to the extent they exceed 2% of adjusted gross income – doesn’t count for alternative minimum tax.

The conference version of the stimulus monstrosity “stimulates” us by including the alternative minimum tax “patch” for 2009 that was sure to pass eventually anyway. The bill (Section 1012) prevents the AMT from applying to 20 million or so new taxpayers by increasing the AMT exemption for 2009 to $70,950 for joint filers and $46,700 for unmarried taxpayers. Absent Congressional action, the exemption would fall to $45,000 for joint filers and $33,750 for unmarried folks.
The bill also extends the rule that allows a bunch of personal credits to apply in computing AMT, including the dependent care credit, the credit for the elderly and permanently disabled, the education credits, and the credit for “nonbusiness energy property.”

Cash is king right now, and the new tax law turns “long-term minimum tax credits” into cash over the next two filing seasons. This prompts a reader question:

In your very informative article 10/6/08 I have a Question on terms; long-term unused minimum tax credits vs. long-term AMT credits. Are they the same under this new legislation? Are they the “minimum tax credit” on from 8801, LIne 28?

The minimum tax credit arises when taxpayers incur alternative minimum tax from items whose timing differs for computing regular tax and AMT. The most famous example of this is incentive stock options, which are taxable upon exercise for computing AMT, but not until the option stock is sold for regular tax. The credit can also be generated by differences in AMT depreciation, amongh other things. Minimum tax credit does not result when AMT is caused by itemized deductions, like state income taxes, miscellaneous deductions, or home equity loan interest.
Minimum tax credits carry forward to reduce regular tax, but only to the level of AMT in a subsequent year. As a practical matter, many minimum tax credits have languished unusable for years.
The new rules enacted in the bailoug bill treat mimimum tax credits that were generated by AMT more than three years before the current tax year as a refundable credit, like wage withholding; half of existing long-term credit can be claimed as a refund in 2008, and the rest in 2009. That means credits generated by AMT in 2004 and earlier will create refunds in 2008.
You may have a long-term mimimum tax credit if you have an amount on your 2007 Form 8801, line 28. To see whether you are eligible to cash out some minimum tax credit in 2008, you need to dig out your 2005 return and turn to Form 8801. If there is is a number on line 19, you may have a long-term minimum tax credit you can use in 2008. If the number doesn’t get smaller on your 2006 8801 line 19 or your 2007 8801 line 19, and your 2007 form 8801 line 28 is at least as high as your 2005 8801 line 19, the 2005 amount is your long-term minimum tax credit carryforward. If your line 19 declined in any of the years after 2005, your smallest line 19 amount for the period should normally be your long-term mimimum tax credit carryforward.
So if you have a Form 8801 on your 2007 1040, it’s time to dig out your old returns and see if the IRS might have some extra cash for you next April.
Related: How the refundable AMT credit works

A reader asks a question that identifies a tricky issue in dealing with ISOs and the minimum tax credit under the new rules enacted last week. I have changed some of his numbers so it works better as an example.

I exercised some ISO’s early in Jan at $180 but the stock has fallen to $80 now. My original intent was to hold until next year for capital gains benefit but knew I had the option of selling them by end of year to make the income regular and avoid AMT calc. With the change in ISO-AMT rules, does this mean that if I paid $420k in AMT for tax year 2008 that I can claim $210k cash back on my 2009 return?

The reader leaves out some important facts, so I will make some up. We will assume that the reader has ISOs for 10,000 shares, and that his exercise price was $30. If he holds the ISO stock for a year, he will have no 2008 regular taxable income on his exercise of incentive stock options, but he will have $150 per share added to his income in computing alternative minimum tax, – $1,500,000 in total. We will assume that this increases his AMT by $420,000: 28% of $1,500,000. This should generate a $420,000 minimum tax credit that may offset future regular tax, but not AMT.
The new tax law makes 50% of long-term unused minimum tax credits refundable, the same as if it were from wage withholding. “Long-term” unused credits are those over three years old. That means any credits generated by 2008 tax won’t become “long-term” until 2012. So the taxpayer will not be able to get 50% back as a refundable credit until 2012; it will only be available to reduce regular tax, but only to the level of AMT. As the rule allowing refunds of long-term minimum tax credit expires after 2012, the remaining 1/2 would never generate a cash refund; it would only offset regular tax. That may not happen for many years.
If the taxpayer’s $420,000 AMT credit had originated in 2003 instead, it would be “long-term” in 2008, and he would, under the new law, be refunded $210,000 in 2008 and $210,000 in 2009.Disqualifying disposition: opting out of ISO treatment
If the reader sells the stock in 2008 at $80, the results differ. If he sells shares acquired by exercising an ISO within 12 months of exercise of the option, he in effect elects out of ISO treatment and the resulting AMT problems. He will have $1,500,000 of ordinary compensation income per share ($180 value – $30 exercise price = $150 x 10,000 shares = $1,500,000). Assuming a 35% rate, that means he will owe $525,000 to the IRS on the shares for 2008. He will also have a capital loss of $700,000, the difference between the $1,500,000 exercise price and the $800,000 sales price at $80 per share. But very importantly, he will have $800,000 cash available to pay the $525,000 tax. If he holds on to the shares that have already fallen in value from $180 to $80, he will be in a pickle if the shares decline more – and further stock declines are certainly possible in today’s economy.
The ISO tax benefit benefit our reader would get by holding onto the shares for a year after exercise is that any gain would then be taxed then at capital gain rates. If the stock stays at $80, the reader will have $500,000 capital gain taxable at 15%, unless the next president and Congress raise capital gain rates for 2009. That would reduce his regular federal tax on the ISO income to $75,000. But he would still probably be unable to use much of the minimum tax credit generated by his 2008 exercise of the ISOs for a number of years, with the big benefit not available 2012.The bottom line? Our reader has to do some thinking on whether the savings of having capital gain treatment of ISOs is worth both the market risk on his stock and the high possibility of having to wait until 2012 to recover taxes due in 2008 if he retains ISO treatment. If the stock goes to zero before he sells it, he has a $420,000 AMT liability and no cash.
Oh, and one more thing: Congress should fix the problem going forward by repealing the ISO rules entirely. They create a dangerous AMT trap for the unwary, and they encourage behavior – holding stock after exercising an option – that would normally not make economic sense.
UPDATE, 10/10/08: more at Long-term minimum tax credits: what are they?

While most of the tax provisions attached to the bailout bill that passed the Senate yesterday were extensions of the “expiring” tax breaks that never actually seem to expire, there are a few new ones. The three original tax provisions of the failed House bill are in there, but there are also a few odd new provisions.
For example, the bill makes all machinery and equipment placed in service in a farming business in 2009 5-year property. Considering that farmers already qualify for the $125,000 Sec. 179 deduction for such property, this is a nice little spiff for an industry enjoying some of its most profitable times ever.
The bill also extends the Section 199 domestic production boondoggle to our strategic film and television production industry; this will enable the economy to pull itself up by its sitcoms.
Oddly, the bill caps the Section 199 deduction for domestic oil production at 3%, vs. the usual 6%, so as not to encourage too much of that; heaven knows we don’t need any more domestically-produced oil.ISO-AMT victims will get to claim as cash refunds up to 50% of their unused long-term AMT credits, starting in 2008. The bill also abates all interest and penalties attributable to unpaid taxes on ISOs, with a credit for those who have already paid such interest and penalties.The bill imposes information reporting on brokers, requiring them to report on 1099s the basis and gain on securities trades, starting in 2011.
And perhaps most importantly, the bill exempts children’s wooden practice arrows from the 39-cent-per-shaft excise tax otherwise imposed on arrows. And why shouldn’t Congress shaft us a bit more?
A roundup of the provisions is below the fold. You can check with the TaxProf and the TaxGrrl for additional coverage.
Links:Text of Senate Bill
Related: Saving the economy, one tax preparer at a time

Grassley insisted that Wall Street itself had an important role in a crisis that has focused more on Congress in the past week.
“I’ve suggested that it wouldn’t be a bad thing if the leadership of these investment banks and financial institutions and Fannie May and Freddie Mac would take a Japanese approach to corporate governance. And I’m not talking about going out and committing suicide,” Grassley, a Republican, told reporters during a morning conference call.
“The CEOs go before the board of the directors, before the public and before the stockholders and bow deeply and apologize for their mismanagement,” Grassley said.

That’s a great idea, Senator. And as a supreme moral leader, it would only be fitting for you and your fellow Congresscritters to set the right example. Senator Dodd and Congressman Frank could start by standing on the mall and undergoing a Cultural Revolution-style self-criticism for enabling and encouraging Fannie and Freddie to insolvency, and for being silent while their well-connected executives took fabulous salaries while shoveling cash to their campaign funds. They should then resign and join a Trappist monestary, living out the rest of their days in silence while they contemplate and atone for their deeds while sparing us any further legislative mastery. In fact, all of Fannie’s favorites could do some bowing and scraping.
Senator Grassley, a member of the taxwriting committees since the 1980s, could then step up to the platform to apologize, along with all of his taxwriting colleagues, for continuing to encourage overinvestment and overleveraging in the housing market through expansion of tax incentives for home ownership, home speculation, and mortgage borrowing.
Then, once the congresscritters who have made all of this possible stand up and take their own responsibility, then by all means bring on the executives. By then the crowd should be about out of eggs and tomatoes.

The text of the Senate version of the bailout is available, courtesy of The Wall Street Journal. It looks to be the House bill, with increased deposit insurance and the extension of expiring provisions, including the AMT patch.
It contains one provision dear to the hearts of tax preparers: it repeals the rule that subjected preparers to penalties for positions that would not be penalized if taken by taxpayers doing their own returns. Hey, it’s a sacrifice we preparers are willing to make to save the financial system. We’re just that nice.
It’s pretty sad, actually. If the bailout is a good thing (I think it is, if only compared to the potential for disaster if nothing is done), you shouldn’t have to bribe legislators to support it by attaching the extenders bill, which is a hodgepodge of largely bogus or silly tax breaks that are regularly re-enacted with a one or two year life to disguise their true cost, and to provoke regular visits from lobbyists bearing campaign money. Congress continues to earn it’s 9% approval rating.
UPDATE: More on the tax provisions of the bailout.

Senate Finance Committee Ranking Member Charles Grassley today announced that he has secured a commitment from the IRS to suspend the collection of the AMT (including interest and penalties) arising out of employees

So the AMT can make your effective rate on capital gains higher than 15%? Tough, says the Tax Court:

Petitioners’ first objection to the application of the AMT is that it contravenes a 2001 statutory enactment of a 15-percent tax rate on capital gains. Petitioners assert that the application of the AMT makes the effective rate on their capital gain income slightly more than 15 percent. In their own words, petitioners contend that the “application of AMT [is] * * * rendered null and void” because of this contravention.

If only it were that easy.

In computing the AMT there is a special computational provision for taxpayers with net capital gains. Generally speaking, the net capital gain income is multiplied by 15 percent and the result is added to the tax on other income which is computed in the manner described above. Sec. 55(b)(3). Following this computational provision, petitioners’ AMT is computed at $7,007, which petitioners contend causes their net capital gain income to be taxed at an effective rate slightly greater than 15 percent because of the disallowance of the entire amount of the standard deduction and exemptions.
Petitioners’ position would require a change to the statute that would apportion the disallowed items. Ultimately, however, respondent’s computation is in accord with the statutes, and petitioners’ argument fails.

The moral? The tax law is enforced based on what Congress actually did — not on what you think they were trying to do.
Cite: Fritz, T.C. Summ. Op. 2008-81.